Question

case file #4: the smokestack
a manufacturing plant emits sulfur dioxide from its smokestacks. this pollution causes acid rain that damages car paint, building exteriors, and kills fish in nearby lakes within a 10 - mile radius. the company pays nothing for this environmental damage.
analysis:
type of externality: positive / negative (highlight one)
who creates the externality?

whos affected and how?

market failure: is too much or too little manufacturing happening? explain why.

policy solution: suggest one realistic way to fix this market failure.

Explanation:

• Type of externality: Negative because the manufacturing plant's sulfur dioxide emissions cause harm (acid rain damaging car paint, building exteriors, killing fish) without the company bearing the cost of that harm.
• Who creates the externality: The manufacturing plant. It is the entity emitting the sulfur dioxide which leads to the negative impacts.
• Who's affected and how: Car owners (damaged paint), building owners (damaged exteriors), and the ecosystem (fish in nearby lakes killed) within a 10 - mile radius. The acid rain directly causes physical damage to inanimate objects (cars, buildings) and harm to living organisms (fish).
• Market failure: Too much manufacturing is happening. The firm does not account for the external cost (environmental damage). In a free - market without considering this externality, the firm's private cost is lower than the social cost. So, the firm overproduces (compared to the socially optimal level) as it only looks at its own cost (private cost) and not the total cost (private + external cost) to society.
• Policy solution: A Pigouvian tax. The government could impose a tax on the manufacturing plant equal to the external cost per unit of output (sulfur dioxide emission). This would increase the firm's cost (making private cost equal to social cost), and the firm would reduce production to the socially optimal level.

Answer:

• Type of externality: Negative
• Who creates the externality: The manufacturing plant
• Who's affected and how: Car owners (damaged paint), building owners (damaged exteriors), fish in nearby lakes (killed) within a 10 - mile radius
• Market failure: Too much manufacturing. Firm ignores external cost (private cost < social cost)
• Policy solution: Pigouvian tax (tax on sulfur dioxide emissions equal to external cost)